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An interesting report from the law firm Cooley crossed my
desk this week titled “Cooley Venture Financing Report” – ok,
maybe not that interesting – but the report looked at their 2Q12
venture deals (n=82), so presumably a representative
perspective on what is going on with valuations and, nearly as
important, terms.

The two headline trends surprised me: valuations tended to be up
and terms were balanced between company and investor. So now some
of the data:

Valuations: Pre-money valuations for Series A,
B, C and D+ rounds were $11, $40, $54 and $140 million,
respectively. I am surprised at how high the Series A and B
rounds were priced and at how low the Series C rounds were
valued (and who knows what are in the Series D+ data so I will
ignore those deals). Let me explain. Series A round sizes have
been coming down over the last few years as companies can get
by with raising less capital and given the crummy general
economic conditions; therefore I expected valuations for Series
A to be a fraction of the $11 million witnessed. If companies
are raising ~$5 million in typical Series A rounds, this means
that early investors are getting a 2+x mark-up’s in the Series
B rounds and management is not suffering as much dilution
(remember it is not how much you raise, but how much you own).
Now Series B rounds tend to be $10 to $15 million in size,
which implies that the C round valuations are basically flat to
the B round. Arguably the risk profile of many Series A
companies is not meaningfully different than that of a Series B
company (lack of repeatable sustainable commercial proof
points, maybe incomplete team, product development still work
in progress, etc) – thus my surprise. Similar risk at very
different valuations.

Terms: I expected the pendulum to
swing very much in the favor of investors for two reasons –
capital is so scarce and with the bifurcation of the venture
capital industry (large vs small firms), I expected to see more
punitive terms come to the fore to drive syndicate alignment and
good investor behavior as smaller, weaker VC’s run out of
capacity (entrepreneurs – be very thoughtful about how you
construct your investor syndicate). I had also expected to see
more “financial engineering” introduced into term sheets so that
VC’s could convince themselves of generating a reasonable return
even in a modest outcome. I will highlight a couple of the more
controversial terms and what Cooley saw in the 2Q12 data.

Liquidation Preference – Across all 82
deals in this cohort, 100% had <=1.0x liquidation preference
which was very surprising to me. In a typical quarter we see
10-15% of all deals with preference greater than 1.0x, so while
not a significant percent, it is always present.

Participation – Appeared to be more prevalent
across all Series of rounds; in early rounds participation was
present nearly 75% of the time and in later rounds, it was
there around 55% of the time.

Recapitalizations – I had expected this
phenomenon to be quite evident but in fact it was only in 12%
of the Cooley deals (it had been between 6-8% for the previous
five quarters. With the explosion of new company creation over
the past few years, I thought we would see many tired
syndicates looking for a fresh start.

Tranched Deals – For many of the same reasons
as with recaps, I expected to see this be a very big number but
it was only 15% of the time, and actually down from the typical
20-25% from prior quarters.

Pay-to-Play – This was probably the most
surprising one for me. Only 18% of deals (and only with Series
C) was this term present. This speaks directly to
ensuring a strong supportive syndicate; if some investors stop
supporting the company, there would be punitive ramifications.
I had expected this to be closer to historic norms of 25 to 30%
of deals.